In the 2013 Retirement Confidence Survey conducted by the Employee Benefit Research Institute (EBRI), workers aged 55 and older said the following about their retirement savings:
- 60% have less than $100,000 in retirement savings
- 43% have saved less than $25,000
- 36% have saved less than $10,000
As a point of reference, of all workers surveyed:
- 76% have less than $100,000 saved
- 57% have less than $25,000 saved
- 46% have less than $10,000 saved
Given these results, it is evident that a significant number of those retiring today and in the near future are woefully underprepared with respect to savings for their retirement. Though Social Security exists to prevent many of those who have not saved from having to live on the streets, it likely does not provide an adequate amount to replace or supplement the lifestyle they may have been used to prior to retirement. One tool that exists for homeowners to help bridge this gap and provide potential income in excess of social security is a reverse mortgage.
What is a Reverse Mortgage?
For those who own their own home and are at least 62 years of age or older and have some equity in their home, a reverse mortgage provides an opportunity to convert that equity into cash. Essentially another way to look at it is that a reverse mortgage gives you the ability to access all of the equity you have paid towards owning your home without having to repay it during your lifetime as long as you are living in the home and have not sold it. Though home equity loans operate in a similar manner, they require repayment which reverse mortgages do not as long as the above stipulations are met.
How do They Work?
The way in which these vehicles operate is that with a reverse mortgage, a lender will make payments to you based upon a percentage of the value of your home which they then have access to (in excess of your equity) to repossess should you no longer occupy the property. There are many different types of reverse mortgages that exist both offered publicly through the federal government and privately through banks and other lenders. Regardless of the type of lender, they all share the following similar features:
- The reverse mortgage must be the primary debt on your home. Other lenders must be repaid or must agree to put their loans in lower priority to the primary mortgage holder.
- Financing fees can be included in overall loan costs
- Older homeowners generally qualify for higher loan amounts than those younger in age.
- The lender can request repayment in the event you do the following:
- Fail to maintain proper insurance
- Fail to provide adequate maintenance
- Fail to pay property taxes
- Declare bankruptcy
- Abandon the property
- Commit fraud
- Have the home condemned, add a new owner to the property title, sublet all or part of the property, change the property zoning classification or take additional loans on the property.
Two Types of Reverse Mortgages
Home Equity Conversion Mortgages (HECM)’s are the only reverse mortgages issued by the federal government. Since they are publicly offered through the government this limits costs to borrowers and guarantees lenders meet obligations. The only downside is the amount loaned is based on an amount limited to the lesser of the appraised value or $625,500.
Non- public reverse mortgages are available at many lending institutions. The biggest advantage of these mortgages is that the loan amount offered is not limited as with HECM’s. Though this is the case, these loans are not federally insured and can often be more costly than HECM’s.
Things to Pay Attention To:
Total Annual Loan Cost
Though the HECM has a set interest rate through the federal government and origination costs are limited to 2% of the value of your home plus 1% over $200,000 up to a maximum of $6,000, the overall loan cost can still vary by lender. Variables to consider when looking at lenders include third-party closing costs, mortgage insurance and servicing fees. All lenders are required to provide borrowers with a cost disclosure detailing the Total Annual Loan Cost (TALC). This number should be used when making comparisons.
HECM loans have significant flexibility when it comes to payout options. These options can include monthly cash advances, credit lines, lump-sum payouts, or even a combination of these options. Non-HECM loans offer fewer options and less flexibility from this standpoint.
Interest rates on HECM reverse mortgages are tied to the one-year U.S. Treasury rate. Borrowers have the ability to choose an interest rate that can change on an annual or monthly basis. Annual rates change based on the one-year U.S. Treasury rate capped at 2% per year or 5% over the loan’s term. Monthly rates are based on a rate lower than an Adjustable Rate Mortgage (ARM) and adjust on a monthly basis. The variability of changes in the rate are limited to 10% over the loan’s term.
If you are thinking about taking out a reverse mortgage, there are many things to consider before you finalize your decision including whether or not you have any legacy intentions based on the sale of the value of your home, whether or not you can afford the costs involved with loan origination, servicing and interest fees, your future health and whether you can stay in your home through its term. Depending on the size of the loan and your home property, the funds available to your heirs will be minimal. As a result of all of these factors, be sure to discuss your decision and weigh your options in detail with a CFP® professional or a Reverse Mortgage Specialist.
By: Kyle Grabenstetter MS – July 23, 2014
“Retirement Confidence Survey,” Employee Benefit Research Institute, 2013.